MS. ZUCCHINI: Good morning, I am Silvia Zucchini from the External Relations Department of the IMF. Welcome to our press call on the new Staff Discussion Note (SDN) on the Banking Union for the Euro Area. We will be happy to take questions, but before, we will open with staff remarks from the lead author. Mahmood Pradhan is the Deputy Director of the IMF European Department. There are a number of other authors in the room, and I am going to introduce them individually.

all of you. Let me give you an introduction and a little bit of background to the paper, and then we will be happy to take your questions.

Firstly, just to tell where this SDN originates from. In our Article IV consultation with the euro area last year, we had made a strong call that, to complete part of the architecture for the monetary union, the euro area needed a banking union. This paper is a follow-up that outlines in a fair amount of detail what would constitute a banking union. Let me say, as an additional introductory remark that, compared to where we were last summer, when we were arguing and persuading the Europeans to embark on this project, we think the progress has been very substantial, in terms of beginning to put in place the elements of a banking union.

The paper outlines the three key elements of a complete banking union: one is common supervision. The second is common resolution, which would need a resolution authority. And the third is common safety net. We think that these three elements together would promote financial stability. Further, a key feature of the crisis in the euro area is the very strong links between the borrowing costs of sovereigns and banks. A banking union would help substantially weaken these links, and thus promote economic stability and a more resilient monetary union.

Now, let me just explain what we think each of these key elements would achieve. Let me start with "common supervision," which, as you know, will be in place reasonably soon. The Europeans have agreed to that. It will be housed at the ECB. Common supervision in Europe would, first and foremost, address financial market fragmentation. What is unusual about the euro area, for a currency union, is that liquidity still remains largely in member states and national jurisdictions, or in national banking systems. And this liquidity does not move around the euro area as it should in the spirit of a single market. It reflects national regulators' and supervisors' concerns about their own banking system and their cross-border exposures. So they are encouraged to keep liquidity in their home market, which leads to financial fragmentation. As we document in the paper, it results in very different borrowing rates across the euro area. We therefore think that common supervision will not only raise standards of supervision and limit the buildup of excessive risk concentrations that threaten systemic stability but will also address financial market fragmentation.

"Resolution," currently, when there are problems in banks, is the responsibility of member states at the national level. We think that this should move to the center, at the supranational level, to help break these sovereign-bank links. The issues around resolution are, at least in the public debate, largely centered on the cost of it. In our view, you can pay for most resolution cases via the industry itself, with some kind of levy. But there will always need to be a common and credible backstop for systemic cases or for cases where problems may start in what appear to be small banks but then spread because of correlated exposures. So you always need a backstop from the center.

In the long run, the history of banking crises tells us that the costs to the public sector of resolution do not always need to be very large. But in order to address the crisis when it happens, you do need an immediate and an effective backstop. And that, in our view, has to be provided by the public sector, with access to central bank liquidity.

Finally, the third element of a banking union—a common safety net—really speaks to the issue of standardizing and providing a common deposit insurance. Now, that is a step further out in time. We would argue that it should form a key element of the banking union. But we recognize that it will take time. In Europe, this is currently being addressed to start with through the EU Directive to standardize national deposit insurance systems and harmonize them. Later on, we hope that this will lead to a common deposit insurance for the euro area.

Finally, let me speak to one element of the banking union, which—going back to the Leaders’ Summit last summer—we have asked and called for, that is direct recapitalization of banks from the center. They have addressed this by requiring first common supervision to be in place, and then to allow the ESM to take direct stakes in banks without sovereigns incurring this liability. We hope that will come when common supervision is in place.

Let me stop there with these introductory remarks, and I will be happy to take your questions, together with my colleagues.

QUESTION: You said in the beginning that a lot has been accomplished. Where do you see the biggest risk in this banking union today? Is it that it does not happen fast enough or that it does not include the right elements?

MR. PRADHAN: Rather than calling it a risk, I would say that implementation and continuing to sustain progress is probably the most important aspect. So, right now, that would be implementation of common supervision, and that entails—as you will see from the background papers-a number of aspects, both in terms of building capacity to supervise from the center at the ECB, working well with national regulators, information sharing aspects, and so on.

So, rather than calling it a risk, I will say it is important to implement the plans as they stand today.

QUESTION: I am wondering if you could comment on the news that the euro zone have been starting to set up the mechanism for direct recapitalization, and how to deal with legacy assets. You say in your paper that you do not think there should be some kind of sovereign guarantee, or first-loss absorption protection. But how do you think that the euro zone should deal with legacy assets? You say that there should be provisioning in advance, cushioned by the national government. But how would that work in practice?

MR. GOYAL: What we suggest in the paper is that there needs to be clarity on the state of the balance sheets. The private sector and the domestic sovereign should be putting in money as a first resort. This should happen at least until the point when the bank has positive, or non-negative, capital. To be clear, we are talking about domestically systemic banks. Non-systemic banks ought to be wound down with resort to domestic deposit insurance or resolution funds.

For ESM direct recap, our thinking is that it ought to come in, first and foremost, to try to break sovereign-bank links, in a way that makes sure that future unexpected losses are the ones that the ESM direct recap is meant to cover. What should be clear is that expected losses are ones that we argue should be covered by the shareholders, and also by the domestic government.

MS. PAZARBASIOGLU: I would like to add a point. The definition of “legacy” needs to be discussed. In that sense, if an asset is not performing, but if it is provisioned sufficiently, if— as Rishi said—the expected losses are taken into account, then it is difficult to characterize that asset as a legacy asset. “Legacy” means that what you have on your books does not really represent the true pricing of that particular asset. But if the losses are written off or if the asset is adequately provisioned, then it is no longer a legacy asset but, rather, an asset that is properly priced and should be performing going forward.

QUESTION: Which measures and when will be implemented as a common safety net? Secondly, in the financial market integration and (inaudible), what is the position of Portugal in the euro area? And the last one, (inaudible) will affect not only the euro zone, but also other countries like the United States. I would like to know how Europe could be affected, economically, if any risk to (inaudible)?

MR. PRADHAN: If I understand your question, as I said in my introductory remarks, the common safety net at the euro area level is an element of the banking union that will not be implemented or put in place in the near future.

Thierry can address this question of where we stand on the common safety net in the euro area at present. Then I will come back to the financial market fragmentation in Portugal.

MR. TRESSEL: Safety nets in the euro area remain nationally based. However, as Mahmood said, we see as important that over time common safety net move to the center, and are part of one of the key elements of the banking union. Safety net for resolution should be moved to the center and have common funding, which will be part—as we say in the paper—ex ante and ex post. We need a fiscal backstop in the near term, or the medium term, to ensure effectiveness of resolution. At the moment, in the EU, directives are being negotiated to harmonize resolution regimes and deposit guarantee schemes (DGS), including the possibility of having borrowing arrangements between national resolution funds or DGS.

MR. PRADHAN: Coming back to your question on Portugal and the financial market fragmentation, I would say that this is one example where we see the effect of the absence of a banking union. By that I mean that if you look at Portugal's sovereign borrowing costs, they are still high, but have fallen very substantially, through various measures at the euro area level to address the crisis and including Portugal's own adjustment efforts. But what you still see in Portugal is that the health of their own banks is not strong, and borrowing rates for the private sector, particularly for corporates and households, are still very high and substantially higher than in many other parts of the euro area. That's exactly what we refer to as "financial market fragmentation."

In a full banking union, you would hope that Portugal's borrowing rates for the private sector, for households and corporate, reflect the adjustment challenges that they, rather than their sovereign, face.

QUESTION: I would like to ask about the resolution side and the steps you were outlining to move to a kind a fully-fledged resolution authority. You mentioned burden sharing, and I was wondering if you could unpack that a bit. Is that burden sharing in terms of giving up who's responsible for what in a cross-border bank? Or do you mean that, if a national bank goes down, there would be burden sharing of any support that is provided? Secondly, you mentioned that you might need treaty changes to establish a resolution authority with full powers, and that a temporary agency might be an option in the meantime. Would that temporary agency have the authority to really wind up a bank, or would they be playing a kind of coordinating role between national authorities?

MR. PRADHAN: I'm going to ask a couple of colleagues to join in, especially on what aspects may or may not require treaty changes. On your first question, about burden sharing, my general point is that if you have a common resolution authority funded at the center, implicitly there is burden sharing. The point I was making was that the scale of that burden does not need to be very large. The history of banking crises tells us that the public sector involvement may look large at the beginning, but eventually when there is recovery, the net cost of the crisis is not as high as it might first appear.

Secondly, as Rishi mentioned, we are talking about the public sector being an eventual backstop. As you know, some of the proposed changes in regulations will involve the private sector in sharing burdens as well other stakeholders, including through a hierarchy of claims.

MS. PAZARBASIOGLU: I want to mention that—as part of a broader international reform agenda—key attributes of effective resolution, in terms of bail-inable instruments, and cross-border arrangements, in terms of cooperation and facilitating such orderly resolution practices, have been put together. The European Resolution Directive takes these into account. So, from a more global perspective, because banks are not only in the euro area but also elsewhere, it is going to be important to have a mechanism for public backstops at the euro level as well as arrangements at the more international level, including bail-inable instruments and facilitative arrangements, like the recent one with the FDIC and Bank of England. These will be important to make sure that cross-border banks can be resolved in an effective manner.

MR. PRADHAN: I understand the specific question is whether a temporary agency would have the authority to wind down a bank. In our view, any resolution authority would need to work with a common supervisor and together, collectively, they have the authority to wind down a bank. We are not saying who has to assume this power of being the resolution authority. That can be any entity. But it would have to be credible and with a credible backstop. I want to give the floor to Ross, who can talk about the likelihood of changes to the EU treaty.

MS. LECKOW: As a general point, ultimately we are talking about questions in EU law, and we would defer on these issues to the lawyers within the European Union institutions. Generally, our view is that, to establish a central resolution authority with extensive resolution powers that would displace national authorities, a treaty change would appear to be necessary.

With respect to the possibility of setting up some sort of temporary agency, I think you will see that the background paper is somewhat agnostic, in the sense that even that may require a treaty change, and, specifically, would depend on what powers that agency were given. I would note that many of the agencies that have been established under the relevant provisions of the European treaties tend to play a role in harmonization of rules and coordination, rather than having the kind of extensive powers that one would need for a central resolution authority.

QUESTION: You talk about "well-defined timetable" at the outset for the further steps. What do you have in mind? Can you tell us what the timeline should be and how long it should stretch out?

The report seems to hedge a little bit on whether failing to complete the banking union would be worse than the status quo. You have a line in there saying “missing elements would result in an incoherent banking union and, at worst, an architecture inferior to the current national-based one." Could you just string that out a little bit?

MS. KOEVA BROOKS: I think the plan is to implement all three elements of the banking union—not only the single supervisory mechanism, but also the single resolution authority, and, eventually, progress towards a safety net. As Mahmood said at the beginning, we understand that some of these elements would take more time to implement, including the agreement on a common backstop. So, in some ways, the specific dates are not as critical as the plan itself. But making that clear, and communicating it to the public and to markets, will anchor confidence and help the euro area come out of the crisis.

QUESTION: That is all very fine, and it's fairly clear from the report. But what have you got in mind?

MS. KOEVA BROOKS: I think a time horizon of 2-5 years seems realistic.

MR. PRADHAN: If I understand your question, namely whether a missing element actually could be counterproductive. I want to ask Giovanni to speak to that and, in particular, the connection between common supervision and resolution.

MR. DELL'ARICCIA: I think the point that we want to make is that, in order for this new arrangement to work, it has to have, at least over the medium run, all three elements. The risks with an incomplete banking union are that the governance and the incentives associated with that incompleteness could lead to problems. In particular, there are basic principles on banking supervision and regulation that basically say that the power has to be where the money is. And so if you transfer supervision and resolution to the center, you also need to transfer also, over the medium run, the safety net. One thing cannot go without the other. At the same time, you do not want to have a safety net at the center, if the supervision and resolution powers are not there, and that is a good principle that is in the current proposal. That is why it is a good start.